Fed Hikes Back On The Agenda - Bezek's Daily Briefing

Summary

Stocks zoom after positive jobs report.

I think this is the wrong reaction.

Yield chase isn't just in developed markets. Things getting out of hand in emerging markets as well.

Markets are flying higher this morning following a blowout jobs report number. The 287k figure beat expectations by more than 100,000 jobs, making it the biggest deviation from expectations since 2009.

The S&P 500 (NYSEARCA:SPY) is set to open well above 2,100, reaching new post-Brexit highs. Meanwhile, the fear trade is in reverse. Long bonds (NYSEARCA:TLT) have sold off somewhat (though less than you would expect). Gold (NYSEARCA:GLD) and silver (NYSEARCA:SLV) dumped, though they are bouncing following the initial reaction.

There are several things to read into the initial reaction to this data point. First, the market is full-on bullish; it wants any excuse to go higher. With the reminder that the jobs data is a noisy data series, this report is still so unexpectedly positive on the economy that the forward outlook has significantly shifted.

You can probably forget the chance of a rate cut in 2016 now. The Fed is still biased toward hikes, and with US equities shrugging off major negative European developments, it appeared the Fed already had cover to largely ignore post-Brexit shocks to the system.

Now, with this freakishly strong jobs report, the Fed can argue for the necessity of more rate hikes. I'd still argue it'd be a counterproductive move since the balance of US economic data is sluggish. However, if the Fed wants to hike, it can now do so with the job market strong and stocks approaching new highs.

Thus, this equity move Friday morning seems incorrect. Yes, it's good news that the labor market is stronger than expected, but this should be more or less cancelled by the fact that Yellen will use this information to create more market instability as she jawbones toward more hawkishness.

Of note, the US dollar (NYSEARCA:UUP), at least so far, has held steady on the jobs report, as the euro (NYSEARCA:FXE) has slid. This is not the normal reaction you'd expect; the dollar should be a lot lower if this is really a positive development for the markets.

The economic situation in Europe, particularly with the banks, still offers great peril for global markets. A US jobs number that shines a favorable light on the economy but greatly boosts the odds of a Fed hike is hardly a major bullish development. Consider me skeptical of this rally.

The Bond Yield Chase Goes Global

In an underreported story, emerging market bonds are also on a tear. Make no mistake, this isn't just a developed market phenomenon, we're back to the stage of yield chase where even questionable credits can get funded at attractive rates. Here's the operative chart, with credit to Charlie Bilello:

If you buy an emerging bonds fund such as EMLC for example, what are you getting? Here's a look at the top holdings:

Chile is rock-solid. At an AA- credit rating and having the most market-friendly government in the Americas, I've got no issues lending to Chile. But beyond that, this is a fairly hairy mix of credits. The second and third largest positions are in Brazil, which is already deeply junk rated and will probably need a massive IMF bailout to avoid default within the next couple years.

Mexico, having benefited greatly from NAFTA, now has a strong economy; it's in a far different place than during the Tequila Crisis days. Assuming a future President Trump doesn't throw a spanner in the works, Mexico should be good for its debts. However, it's not exactly a triple-A credit.

After that, you've got Indonesia, which is junk rated albeit BB+, which is at the top of the junk pile. Still, it is equally rated with Azerbaijan, Russia, and Hungary, which hardly inspires confidence.

You've got the Philippines and Thailand, which are both in the low end of investment grade. So, alright I guess. And finally, you have South Africa, which clings to the bottom rung of investment grade with a negative rating outlook. The country's currency has suffered severe dislocations this year, and the political situation grows ever more tenuous.

In all, for this delightful assembly of emerging market bonds, you now earn a 5.4% yield. And this isn't shielded from currency risk. If the dollar keeps rising against the various generally low-quality currencies that this debt is denominated in, you'll lose a good chunk of that 5.4% yield to FX translation effects.

Why are people chasing low-quality paper from countries like Brazil to ever-higher heights? We've got a global yield chase on. When it ends, no one knows, but the results in this case won't be pretty. I'm reminded of the fools that bought Mongolian long-term bonds at 5% a couple years ago when that country was heavily hyped in the western media.

The timing of the outcome with this latest surge in emerging market paper is uncertain, but eventual failure for today's buyers is assured.

Disclosure:I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.